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Should you access your pension pot early?

Accessing your pension pots early has become the new norm, according to a Financial Conduct Authority (FCA) report. With more people taking advantage of pension freedom laws, should you be looking more closely at your pension options?

72% of pension pots accessed early by consumers

FCA raises concerns over lack of trust in pensions

Make sure you get the right pensions advice

Financial journalist Kalpana Fitzpatrick (@KalpanaFitz) talks to Ros Altmann (@rosaltmann), former pensions minister and a retirement expert, about what the report means for pension planners.

Taking advantage of the pension freedom laws

Pension freedom laws, which came into force in April 2015, give consumers greater flexibility over their retirement funds. Those aged 55 and over who have a defined contribution fund may choose to either buy an annuity, opt for drawdown or take the cash.

Almost three quarters of pension pots are now accessed by those under the age of 65, with 53% choosing to take out all the money, the FCA report found. However, most of the pots that were fully withdrawn were worth less than £30,000.

The FCA also found that drawdown was a popular choice: twice as many pots are now moving into drawdown than annuities.

Drawdown allows you to take money from your pot as and when you need. You can keep the rest of your pension pot invested. The income you get depends on the fund’s performance and income is not guaranteed for life.

Is early pension access right for me?

Although the new pension freedom laws have given consumers the flexibility to do as they please with their pension pot, withdrawing money prematurely may not always be the right move, and you should review your pension options thoroughly before deciding – here are some of the reasons why:

You could end up paying too much tax – the first 25% is tax free, but the rest is taxed at your highest tax rate, which could increase your income tax rate

If you take this option, you can’t change your mind

If you take it all now, you won’t be left with a regular income, which means you could be left short of cash in old age

The process may take a while, so you may not be able to access the funds when you want to

You may not actually be able to access the funds, for instance if the pension was part of the settlement after a divorce

‘Taking money out of a pension fund before you really need to will mean you lose the huge tax advantages of pensions. All your money grows free of income tax, no capital gains tax, and if you pass away it can go to your loved ones, free of inheritance tax,’ Ros explains.

Why are people accessing their pensions early?

There is one key benefit to accessing your pensions early, but it doesn’t apply to everyone: if you have a small pot, and have other secure pension income to rely on in retirement, then you could access the money and use it to help repay debt or other essential spending.

Commenting on the findings, Ros Altmann said: ‘It looks like people are taking money out of their pension funds when they receive their wake-up letter from their provider, which prompts them to think their pension is ‘over’ and they now need to decide what to do next.

‘Many are taking their tax-free cash out and then either going into drawdown or deciding to cash in the whole fund if they have other pensions and it is not a large amount,’ she added. ‘But in general, the FCA figures do not show a clear enough picture of what is happening, and it seems clear to me that people need proper guidance and advice before they make the irreversible decision to take money out of their pension fund.’

Ros said there were concerns not enough people were getting the help they needed, resulting in them taking money out too soon or just keeping it in a cash account, which is wasting the huge advantages of pensions.

The FCA's concerns

Although pension freedom laws have been put in place to give consumers choice and flexibility over their retirement money, the FCA said it has concerns.

For example, those taking the money out were not necessarily spending the cash, instead moving them into other savings and investments, meaning consumers could end up paying too much tax and miss out on investment growth.

The report also identified a lack of public trust in pensions, one of the key reasons for withdrawing the money.

The FCA said it was also concerned that consumers were entering into drawdown deals with providers without taking pension advice.

‘Before the freedoms, 5% of drawdown was bought without advice compared to 30% now. Drawdown is complex and these consumers may need more support and protection,’ the FCA stated.

The FCA could intervene

The FCA said it would assess whether more protection is needed for consumers who buy drawdown without advice.

If so, it will ask the government to consider proposals that enable consumers to access their savings early without having to make a decision about the rest of the pot.

The FCA also wants to make it easier for consumers to shop around for drawdown, as well as provide tools and services for savers to help them better understand pension freedoms.

Improving trust in pensions is also vital, where regulators work with the pensions industry, the government and consumer bodies to help build on existing initiatives,

If you’re facing an unexpected life-changing event, such as serious ill health, you may want access to your money. Before you make any kind of decision, it is important to seek pensions advice. You can talk to one of the LV= pension specialists for free, with no obligation. Otherwise, if you're over 50, you can contact Pension Wise.